Cost Value Profite CVP

CHAPTER 3
Cost-Volume-Profit
(CVP)
Analysis
Basic Assumptions
 Changes in production/sales volume are the
sole cause for cost and revenue changes
 Total costs consist of fixed costs and variable
costs
 Revenue and costs behave and can be
graphed as a linear function (a straight line)
To accompany Cost Accounting 12e, by Horngren/Datar/Foster. Copyright © 2006 by Pearson Education. All rights reserved.
3-2
Basic Assumptions, continued
 Selling price, variable cost per unit, and fixed
costs are all known and constant
 In many cases only a single product will be
analyzed. If multiple products are studied,
their relative sales proportions are known and
constant
 The time value of money (interest) is ignored
3-3
Basic Formulae
Total Cost Pretax

Operating Revenues of Operating
Income = from Goods Expenses
Operations Sold
Net Operating Income

Income = Income Taxes
3-4
Contribution Margin
 Contribution Margin equals sales less
variable costs
 CM = S – VC
 Contribution Margin per unit equals unit
selling price less variable cost per unit
 CMu = SP – VCu
3-5
Contribution Margin
 Contribution Margin also equals contribution
margin per unit multiplied by the number of
units sold
 CM = CMu x Q
 Contribution Margin Ratio (percentage)
equals contribution margin per unit divided by
selling price
 CMR = CMu ÷ SP
3-6
Contribution Margin
Income Statement Derivations
 A horizontal presentation of the Contribution
Margin Income Statement:
 Sales – VC – FC = Operating Income (OI)
 (SP x Q) – (VCu x Q) – FC = OI
 Q (SP – VCu) – FC = OI
 Q (CMu) – FC = OI
 Remember this last equation, it will be used
again in a moment
3-7
CVP, Graphically
y
$10,000
Total Operating
revenues income
line
$8,000 Breakeven point = 25 units
Operating
income area
$6,000
Dollars
$5,000
Variable
Breakeven
$4,000
point
costs
Total = 25 units
Total
costs costs
line line
$2,000
Operating
Operating
loss area Fixed
loss area
x
costs
10 20 25 30 40 50
Units Sold
3-8
Breakeven Point
 Recall the last equation in an earlier slide:
 Q (CMu) – FC = OI
 A simple manipulation of this formula, and
setting OI to zero will result in the Breakeven
Point (quantity):
 BEQ = FC ÷ CMu
 At this point, a firm has no profit or loss at
a given sales level
3-9
Breakeven Point, continued
 If per-unit values are not available, the
Breakeven Point may be restated in its
alternate format:
 BE Sales = FC ÷ CMR
3-10
Breakeven Point, extended:
Profit Planning
 With a simple adjustment, the Breakeven
Point formula can be modified to become a
Profit Planning tool
 Profit is now reinstated to the BE formula,
changing it to a simple sales volume equation
 Q = (FC + OI)
CM
3-11
CVP and Income Taxes
 From time to time it is necessary to move back and forth

between pre-tax profit (OI) and after-tax profit (NI),
depending on the facts presented
 After-tax profit can be calculated by:
 OI x (1-Tax Rate) = NI
 NI can substitute into the profit planning equation
through this form:
 OI = I I NI I
(1-Tax Rate)
3-12
Sensitivity Analysis
 CVP provides structure to answer a variety of
“what-if” scenarios
 “What” happens to profit “if”:
 Selling price changes
 Volume changes
 Cost structure changes
 Variable cost per unit changes
 Fixed cost changes
3-13
Margin of Safety
 One indicator of risk, the Margin of Safety
(MOS) measures the distance between
budgeted sales and breakeven sales:
 MOS = Budgeted Sales – BE Sales
 The MOS Ratio removes the firm’s size from
the output, and expresses itself in the form of
a percentage:
 MOS Ratio = MOS ÷ Budgeted Sales
3-14
Operating Leverage
 Operating Leverage (OL) is the effect that fixed

costs have on changes in operating income as
changes occur in units sold, expressed as
changes in contribution margin
 OL = Contribution Margin
Operating Income
 Notice these two items are identical, except for
fixed costs
3-15
Effects of Sales-Mix on CVP
 The formulae presented to this point have assumed a
single product is produced and sold
 A more realistic scenario involves multiple products
sold, in different volumes, with different costs
 For simplicity’s sake, only two products will be
presented, but this could easily be extended to even
more products
3-16
Effects of Sales-Mix on CVP
 A weighted-average CM must be calculated (in this
case, for two products)
Weighted ( Product #1 CMu x Product #1 Q ) + ( Product #2 CMu x Product #2 Q )
Average =
CMu Total Units Sold (Q) for Both Products
 This new CM would be used in CVP equations
Multi- Fixed Costs
Product = Weighted Average CM per unit

BE
3-17
Multiple Cost Drivers
 Variable costs may arise from multiple cost
drivers or activities. A separate variable cost
needs to be calculated for each driver.
Examples include:
 Customer or patient count
 Passenger miles
 Patient days
 Student credit-hours
3-18
Contribution Margin vs.
Gross Profit Comparative Statements
Contribution Margin Income Statement Financial Accounting Income Statement

(Internal-Use Only) GAAP - Based
Revenues: $200 Revenues: $200

Less: Less:
Variable Cost of Goods Sold $120 Cost of Goods Sold $120
Variable Operating Costs 45 165
Contribution Margin 35 Gross Margin (Profit) 80
Fixed Operating Costs 20 Fixed & Variable Operating Costs 65
Operating Income $15 Operating Income $15
3-19

Cost Value Profite CVP

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CHAPTER 3

Total Cost Pretax

Net Operating Income

 From time to time it is necessary to move back and forth

 Operating Leverage (OL) is the effect that fixed

 This new CM would be used in CVP equations

Multi- Fixed Costs

Product = Weighted Average CM per unit

Contribution Margin Income Statement Financial Accounting Income Statement

Revenues: $200 Revenues: $200

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